DP18171 The Cost of Banking with Naivety and Adverse Selection
We build a two-stage model of competition in the banking market to study the combined price of accounts and credit. We include naivety, adverse selection, and imperfect screening. We show that credit market profits are not competed away in the (primary) market for accounts. We establish an Information Penalty: the total cost of banking to consumers is V -shaped in the quality of screening in free banking markets. This implies better AI or use of Big Data first lowers then raises the cost of banking in countries similar to the US/UK. While in paid banking markets we establish a Sophistication Penalty: the cost of banking is ∩-shaped in customer sophistication. This implies improving financial literacy can raise banking costs in countries similar to France/Germany.